Construction companies can face hurdles come tax time, thanks to Internal Revenue Service regulations that affect how revenue can be reported and how deductions are recorded. Some requirements are specific to how a company is structured, while others scrutinize the relationship between a firm and its subcontractors. Firms have to be careful in how they record their financials, or they risk an IRS audit.

Accumulated Earnings

The IRS tracks closely held C corporations to make sure they aren't recording too much accumulated earnings, as opposed to distributing the proceeds, in an effort to limit tax liability for its shareholders. However, construction firms may have more need to keep capital on hand than similar companies in other industries, whether it’s for bonding purposes or to replace heavy equipment when necessary. Because there aren’t any hard-and-fast rules about what constitutes a reasonable need, construction firms should have a consistent, documented approach to their withheld earnings and be able to justify that approach should the IRS perform an audit.

Employment Tax

Many construction firms rely on subcontractors to fill open spots on a project. This can mean the avoidance of employment taxes, since these workers aren’t classified by the company as employees. That might not be the interpretation of the IRS, however. Behavioral control, financial control and the relationship of the parties are the three factors the IRS considers when making its determination. If you’re giving the same individuals 1099s for regular work year after year, for example, that might draw the attention of tax authorities. Not only does that affect the liability for back payroll taxes, it might allow those workers to claim company benefits, such as participation in a retirement plan.

Multiple States

Construction firms operating in multiple locations may have tax obligations in more than one state. When your business has a physical presence in a state, it’s generally considered to have a “nexus” there, which can mean that state expects income and payroll taxes. That obligation depends on the level of the presence in a particular area, and different states have different thresholds.

Tax Strategies

Construction firms can use different strategies to minimize the negative effect of taxation on operations. For example, cost segregation allows companies to separate building components into different asset classes, allowing for accelerated depreciation on shorter-life assets, as opposed to the extended period required in depreciating assets classified as being part of the building. This can result in tax savings and improve cash flow.

Accounting Methods

Not all construction companies have a choice in their accounting methods. If your business is a C corporation with gross receipts greater than $5 million, the IRS generally requires you to use an accrual method of accounting. If merchandise or materials are an income-producing part of your business, you’ll have to use an accrual method for purchase and sales. There are some exceptions in the tax code that allow businesses with average gross receipts of $10 million or less to use the cash method, but it can be difficult to determine whether your firm qualifies without talking to a tax professional.